Focus on Somalia
In the text, the authors have discussed the importance of institutions in installing incentives to entrepreneurship, and thus economic growth. All of the institutions necessary for economic growth can be summarized broadly by using the terms “good government” and “well-functioning markets”. But can entrepreneurship and economic growth occur without the existence of government? Such is the situation in Somalia where no unified government exists, and anarchy thrives. Yes, the telecommunications industry is thriving. Read the article below, which is an excerpt from a BBC article (www.bbc.co.uk). Then discuss the following two questions:
1. Does the absence of government encourage business activity?
2. Given your knowledge of the institutions that are necessary for economic activity, discuss which of these institutions are missing in Somalia.
By Joseph Winter, BBC News in Mogadishu, Somalia. (Article appeared on BBC website on 19th November, 2004)
Rising from the ruins of the Mogadishu skyline are signs of one of Somalia's few success stories in the anarchy of recent years. A host of mobile phone masts testifies to the telecommunications revolution which has taken place despite the absence of any functioning national government since 1991.
Three phone companies are engaged in fierce competition for both mobile and landline customers, while new internet cafes are being set up across the city and the entire country. It takes just three days for a landline to be installed - compared with waiting-lists of many years in neighboring Kenya, where there is a stable, democratic government. And once installed, local calls are free for a monthly fee of just $10.
International calls cost 50 US cents a minute, while surfing the web is charged at 50 US cents an hour - "the cheapest rate in Africa" according to the manager of one internet cafe.
But how do you establish a phone company in a country where there is no government?
In some respects, it is actually easier.
There is no need to get a license and there is no state-run monopoly which prevents new competitors being established.
And of course there is no-one to demand any taxes, which is one reason why prices are so low.
"The government post and telecoms company used to have a monopoly but after the regime was toppled, we were free to set up our own business," says Abdullahi Mohammed Hussein, products and services manager of Telcom Somalia, which was set up in 1994 when Mogadishu was still a war-zone.
"We saw a huge gap in the market, as all previous services had been destroyed. There was a massive demand."
The main airport and port were destroyed in the fighting but businessmen have built small airstrips and use natural harbors, so the phone companies are still able to import their equipment.
Despite the absence of law and order and a functional court system, bills are paid and contracts are enforced by relying on Somalia's traditional clan system, Mr. Abdullahi says.
But in a country divided into hundreds of fiefdoms run by rival warlords, security is a major concern.
While Telcom Somalia has some 25,000 mobile customers - and a similar number have land lines - you very rarely see anyone walking along the streets of Mogadishu chatting on their phone, in case this attracts the attention of a hungry gunman... The phone companies themselves say they are not targeted by the militiamen, even if thieves occasionally steal some of their wires... Mr. Abdullahi says the warlords realise that if they cause trouble for the phone companies, the phones will stop working again, which nobody wants... (Article continues on BBC webpage, but is truncated here for purposes of this question.)
1.) Does the absence of government encourage business activity? Are there benefits for consumers as well?
2.) Given your knowledge of the institutions that are necessary for economic activity, discuss which of these institutions are missing in Somalia.
1.) It is an unusual situation to find an economy without a government, and so when we do find one, it is certainly very useful as a contrast study to other economies. Governments exist in almost all other economies in the world, and so the textbook has identified institutions that can be associated with “good government” and has discussed how these institutions can encourage growth. In Somalia, business is thriving in the absence of a legal system, and a regulatory government. There are some benefits to this, but also some costs. One of the benefits is that businesses do not have to overcome any bureaucracy, so they are not facing a delay in start up costs and time related to red tape. Since there is no government, there is also no threat of corruption and loss of resources related to bribes.
The absence of government also ensures that there are no taxes to pay. These benefits do represent savings for firms that want to operate in this kind of an environment, and thus if one looks at cost savings along, the incentive for business is much greater than in a country that does have a government. The biggest benefit to consumers is the lower cost of the product.
In spite of all these benefits as discussed, there are also significant costs to running a business that has no government. As the last part of the article discusses, people hardly walk around talking on their cell phones because they do not want to attract the attention of some mercenaries. When no government is present, there is no official system to enforce property rights. There is no legal recourse when one’s property is taken away forcibly by another person. The same is true for firms – they have no recourse to the legal establishment of property rights. Although the warlords are not attacking the assets of the telecoms industry in Somalia because they have a self-interest in seeing it preserved, this does not mean that they would not attack other types of industries, particularly if they are owned by rival clans. It is interesting that this is a clear application of Adam Smith’s invisible hand where the warlords are acting out of self interest in seeing the telecom service provided.
If the Somali gunmen and mercenaries were to attack other firms in other industries, then there is no police protection (unless there is a system of private police). It is interesting to note that the clan system establishes the payment of bills and the establishment of contracts so that consumers pay the firms, and the firms provide the services they promise. Thus there is indeed a form of authority that is governing this market. You can think of the clan system as a form of government.
Note that the absence of government means that there is no central agency establishing standards for product attributes and quality. For example, the Food and Drug Administration in the United States checks to see whether products are safe for human consumption. Since there is no central authority like this in Somalia, there are no central guidelines for producers to follow, and this means that consumers could be getting dangerous products.
2.) Property rights and a well functioning legal system are key among the missing institutions in Somalia. Without a government in place, there are no legal title deeds, and though a pseudo-government does exist in the form of a clan system, there is no official property rights identification system, and no official courts to settle disputes.
Incentives for entrepreneurship do exist to a certain extent because firms stand to make large profits in the absence of corruption and taxes. In the telecoms industry in Somalia, the markets are indeed competitive as firms compete to provide services to their consumers in the hope of more profit.
However, it is possible that cost savings due to zero taxes and lack of bribes’ charges could at some point be replaced by “protection” costs exacted by different warlords. Currently there is an absence of “honest government” because no government exists! But if the warlords do start exacting protection money then they would become like dishonest government.
Certainly political stability is very much lacking, as there is no unified government, and no official police force to watch over consumers and firms and protect their assets.
It is a testament to the entrepreneurial spirit that it can survive and thrive under conditions like this, and Somalia is a clear example of Adam Smith’s invisible hand at work. The telecoms firms are existing and working out of self interest (profit), and the warlords are not attacking their firms because of their self-interest (communications), and thus a country in anarchy is able to enjoy the benefits of a modern communication system. The example of Somalia also highlights how certain types of businesses can survive if they are providing a key service even in the absence of almost all the institutions for economic growth. However, this is a rarity and in general all the institutions of “good government” are needed for real GDP per capita to rise.